Many people who want to buy a house find it tough to save cash for a standard down payment — typically 20 percent of the home’s purchase price. Although it can be a good idea to open a separate savings account for your house fund, it can also be tempting to dip into that pot for unrelated expenses that crop up along the way to homeownership.
Instead of a savings account, consider buying certificates of deposit from banks, thrift institutions or credit unions. With CDs, the purchase amount and length of term are fixed. Some CDs have fixed interest rates, whereas others have rates that vary over the term.
Strategically investing via CDs can help you save when your goal is buying a home. And because withdrawing money from a CD early might force you to pay penalties, CDs can keep you from raiding your home fund to pay other expenses.
Here are 10 great CD savings strategies for homebuyers, especially if you are buying your first home.
1. Secure Your Funds
You invest in CDs with a fixed amount of money for a predetermined period of time — typically six months, one year, five years or longer. In return, the bank pays you the interest your CD accrues during that term.
When you buy a CD, you commit for the term. If you redeem it early, you might pay an early withdrawal penalty or lose some of the earned interest. The threat of losing money should keep you focused on your savings goal.
2. Keep Your Investment Safe
Hiding cash under the mattress pays no interest and results in a lumpy bed. Investments like stocks and mutual funds can be risky, so they might not be the best places to stash funds earmarked for a home purchase. You don’t want to lose your savings if there’s a market downturn.
CDs are a relatively low-risk investment because the FDIC guarantees them in case your bank goes belly-up. Your CDs and deposits should be insured up to $250,000. That’s pretty safe coverage. If you’re buying a million-dollar home, you might spread your CDs among several banks to get this protection.
3. Earn Interest
When saving for a down payment, make your money work for you. Although CD interest rates aren’t stunningly high — particularly for shorter-term CDs — they tend to be better than the lower amounts payable on savings accounts.
Two factors generally determine interest rates on CDs: the length of the term and the amount invested. The longer you commit and the larger the amount, the higher your interest rate is likely to be.
For example, if you invest $3,000 in a six-month CD at Ally Bank, the interest rate is 1.00%. However, if you invest at least $25,000 for five years, your interest rate is 2.50% APY.
4. Use a CD Ladder
CD laddering can be a good savings strategy when buying your first home. Start with the total amount you have to invest and divide it into smaller sums. Purchase CDs of different term lengths. For example, if you have $3,000, you might buy three $1,000 CDs — one each for six-, 12- and 18-month terms. Each time a CD matures, reinvest it in another 18-month CD.
Remember to invest the original CD amount plus the interest that accrued during the term. And if banks have raised their CD rates, you might catch a better deal when you reinvest.
5. Consider Reverse CD Laddering
Reverse laddering is another CD savings strategy. To use reverse CD laddering, first, estimate when you will buy a house. For example, if it’s five years from now, start by purchasing a five-year CD this year. Next year, buy a four-year CD, and so on. Eventually, you cash in all the CDs in the year you plan to buy a home.
Although shorter-term CDs generally earn lower interest rates, one big advantage of reverse laddering is that you can potentially catch higher interest rates if rates rise while avoiding big cash commitments for long terms.
6. Shop Around
You should shop around when opening checking accounts, credit card accounts or loans. Similarly, you must do your homework when choosing CDs.
There’s a wide range of choices for CDs, even within one financial institution’s offerings. Make sure you compare apples to apples — the same investment amount for an equivalent period of time. For example, at Barclays Bank Delaware, there’s no minimum deposit requirement for CDs, whereas Discover CDs require a deposit of at least $2,500.
7. Check Other Banks Once Your CD Matures
When your CD matures, you have several options. Typically, you can withdraw your money, add funds or let the CD automatically renew.
If you use CD laddering or reverse laddering strategies when saving for a house, check the interest rates at other financial institutions when it’s time to buy a CD. The easiest option is to roll it into a new CD at the same bank. However, you should look to see if there are better offerings elsewhere. But always make sure you’re comparing the same variables.
8. Save Before You Buy
Although some people like saving small amounts, you might not want to take that approach with CDs for a down payment. Instead, wait until you have accumulated a decent amount of cash before purchasing a CD. Buying too many CDs in small amounts might not yield high returns — plus, it’s difficult to keep track of many different accounts.
Find Out: What Is the Minimum Deposit for a CD?
9. Consider New Offerings
Financial institutions strive to offer unique products, including CDs. Always look for new offerings that weren’t available the last time you bought a CD.
For example, Ally Bank offers a perk on some CDs that allows you to bump up your interest rate during the term if the bank increases its rates for that same term and balance tier. Ally also offers an 11-month no-penalty CD with no early withdrawal fee, provided you keep the CD for at least six days.
10. Beware of Brokered CDs
Although most people buy CDs at banks, thrift institutions or credit unions, some brokerage firms and independent salespeople offer brokered CDs. These investments are more complex than your garden-variety CD.
You might be tempted by these high-interest investments, but with reward comes risk. If you’re going to invest in these products, make sure you understand all the terms. Don’t put all your eggs in one risky basket when you are deciding how to save for a house — the biggest purchase you might ever make.